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Allocation of funding costs to bank branches — Orbitax Tax News & Alerts

The Australian Taxation Office released three Interpretative Decisions (ID) that deal with an allocation of funding costs to Australian branches of foreign banks.

The ATO ID 2012/90 considers a foreign bank with a branch in Australia. The branch is funded locally in AUD (presumably, trying to match the maturity of the branch's assets); however, the bank's global borrowings are longer-term than those of the branch. The bank calculates a hypothetical cost of funding of assets of the branch in AUD using the average term of the bank's global borrowings. It then allocates to the branch the difference between the notional cost and the actual cost of funding as a "funding charge". The ID says that the hypothetical internal charges are not "incurred" by the bank and therefore cannot be deductible to the branch under either the general deductibility rule or specific rules that apply to foreign bank branches.

In ATO ID 2012/91, the ATO considers an allocation to an Australian branch of a foreign bank of an excess of interest charges incurred by the bank globally on funding used to maintain a pool of liquid reserve assets over income derived from the liquid assets. The ID says that an allocation of income from the assets is income "derived" by the branch, whereas an allocation of funding costs are expenses "incurred" by the branch. It is important that additional conditions must be satisfied for derived income to be included in assessable income or incurred expenses to be included in allowable deductions. These conditions depend on whether the branch is a permanent establishment under a tax treaty.

Accordingly, Interpretative Decision ATO ID 2012/92 considers whether an allocation to a treaty permanent establishment of interest expenses incurred by the foreign bank to fund general reserve liquid assets is an allowable deduction to the permanent establishment. The ATO took an accounting, rather than a regulatory approach and noted that the liquid assets are maintained to satisfy liquidity requirements imposed by a foreign regulator. While these assets are available to fund all kind of future cash flows of the bank, they are not used directly by the permanent establishment. The ATO then takes a bold step and declares that therefore the cost of the assets is not an expenditure incurred in the course of business operations carried on by the foreign bank through its Australian branch. The ATO specifically states that the fact that a foreign regulator requires the bank to maintain these asset does not of itself make their cost deductible to the Australian branch and that the head office and the branch do not jointly carry out a single economic function in relation to holding the assets.